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Don't discount the discounters: Section 34 of the Landlord and Tenant Act 1954

The recent unreported County Court judgment in Britel Fund Trustees Limited v. B&Q PLC is important for both landlords and tenants. The key issue concerned the application of section 34 of the Landlord and Tenant Act 1954 (the 1954 Act) in the determination of the open market rental value of premises on lease renewal.

Background

The case concerned an application to the court pursuant to Part II of the 1954 Act to grant a new tenancy of a purpose-built retail DIY warehouse in Tottenham.

The parties had managed to agree all the terms of the renewal lease with the exception of rent. As the landlord (Britel) had plans to redevelop the property, it had been agreed that the proposed 10-year lease would contain a mutual rolling break right exercisable on six months' notice on or at any time after 30 June 2018. Crucially, the court accepted that the landlord's plans were "at such a stage that a prudent prospective tenant would approach the open market negotiation on the basis that it would be operated at 2.5 years".

Section 34 of the 1954 Act

In determining the rent payable the court was required to apply section 34 of the 1954 Act. This provides that, where parties to a lease renewal cannot agree the rent payable, it may instead be:

"determined by the court to be that at which, having regard to the terms of the tenancy (other than those relating to rent), the holding might reasonably be expected to be let in the open market by a willing lessor, there being disregarded:

(a) any effect on rent of the fact that the tenant has or his predecessors in title have been in occupation of the holding …"

In determining rent, the two key issues were:

what allowance should be made for a "rental holiday" such as might be agreed on the grant of a new lease in the open market to compensate a tenant for the time taken to fit out the premises; and

what the effect was of the mutual rolling rent on the rent payable.

Rental holiday

While acknowledging that there was conflicting case law, the court looked at the wording of the 1954 Act and concluded that "the rent is to be ascertained for a lease to be taken by a prospective lessee who is not already in occupation. It follows from the disregard at s.34(1)(a) that the tenant is assumed to have vacated the subject premises".

Although it did not follow that in every open market negotiation of a new lease a tenant would receive a rent-free period for fitting out, the court felt that a retailer operating from these premises would need to fit out in order to trade and therefore a rent-free period of three months would be granted. This would equate to a rental discount of 2.5 per cent across the 10-year term.

The rolling break clause

The application of section 34 assumes that there is an open market rent for the relevant premises. As explained by the court, this in turn is based on the assumption that "there exists a prospective lessee who is not already in occupation and who would be willing to take the lease at that rent". It was this sub-assumption that was to prove particularly problematic in this case.

The parties' initial arguments as to the level of rent had been based on the assumption that there would be a DIY retailer in the open market willing to accept a lease in the form of the renewal lease. However, given that it was felt the rolling break would be triggered by the landlord after only two and a half years, it was conceded that in fact no DIY retailer would be prepared to accept such a lease and that the only prospective tenant would be a discount retailer who would be looking to do a "quick, cheap and dirty" fitting out.

Unfortunately neither side had produced evidence of comparable lettings to discounters as they had both assumed that the calculation would be on the assumption that there was a DIY retailer willing to take the lease. Undeterred, the court went on to conclude that the open market rental value for a lease to a discounter before taking account of the break would be £12.62 psf. Applying a 20 per cent discount for the break, the court concluded that the rent for a discounter on the open market would be £10.10 psf, almost 18 per cent lower than the equivalent rental value the court felt would have been payable had there been a prospective DIY retailer interested in the premises.

Commentary

The court acknowledged that "in the real world B&Q will of course take the lease and will trade in the notional rent-free fitting-out period. However the artificiality of section 34 requires the rent to be judged for a lease to a hypothetical tenant not yet in occupation". In short the fiction of section 34 overrode the facts surrounding this renewal.

In navigating the fiction that is section 34, landlords and tenants should take note of the following, which were highlighted by this case:

the potential effect of early break clauses in renewal leases

This case highlights two potential pitfalls arising from introducing an early break clause in a renewal lease:

it can significantly depreciate the open market rental value irrespective of the identity of the prospective lessee. In this case the court felt the early break clause would warrant a 25 per cent reduction in open market value in the case of a letting to a DIY retailer and a 20 per cent reduction in the case of a discounter; and

it can change and restrict the category of prospective lessees willing to take the lease in the open market (crucially, of course, the court could not consider the existing tenant, B&Q, as one of those contenders).

One factor that did appear to weigh heavily was the strong likelihood that the rolling break in this case would be triggered early on in the term of the renewal lease.

The application of rental holidays

This judgment provides a further endorsement that in appropriate cases a rent holiday will be taken into account even though the actual tenant should have no cause or need to fit out the premises (because it is already in occupation).

The importance of comparables

It is important to have suitable rental comparables for the court to consider. Here the parties were taken off guard and no comparable evidence was provided as to the likely open market rental value of a letting to a discounter. In another recent case, Flanders Community Centre Ltd v. Newham London Borough Council [2016] EWHC 1089 (Ch), the absence of reliable evidence capable of analysis as to current market rent resulted in the rent for a community centre lease renewal remaining at the then passing rent of £1.

The need for consistency

One theme of this judgment was the need for consistency. For example, the court commented on the need to compare like for like.

We ultimately do not know the reasons why the experts did not consider the potential for a discounter to be the hypothetical tenant. There may have been a valid reason for this. However, the case highlights that experts must now consider the categories of user of the premises when ascertaining a rental value pursuant to section 34. It is not enough to assume that the user will be of the same class as the actual tenant.

In summary, the case highlights the disparity between the real world and the hypothetical world. The hypothetical world is a natural fiction. Certain specific facts in the real world can transform a fictional valuation from being loosely based on reality to being a work of fantasy. That is the reality of the real and virtual worlds that expert valuers inhabit.

Further, care should be taken in agreeing terms that are specific to the landlord and tenant's particular situation as such terms may well have more of an impact on rent than the parties initially thought (or even intended). In the fictional world, that is irrelevant and the reality may well turn a fantasy valuation into a nightmare reality.

Compare jurisdictions: Arbitration

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